Balfour Beatty quits – but who cares?

As the Tier 1 contractor turns its back on the gas and water sectors, Denise Chevin asks what this says about the wider relationship between utilities and their supply chain. With a continued move towards Tier 2 (or Tier 1.5) contractors, there may be a tendency to dismiss Balfour Beatty’s concerns, but could complacency come back to haunt the sector eventually?

None of us like rejection, do we? Whether that’s being let go from a job we were about to leave anyway, or being jettisoned by a boyfriend/girlfriend in a relationship both parties had tired of, we all like to be the one who rejects rather than the one rebuffed. It’s human nature.

So, it’s not beyond reason to think that utility companies might be feeling somewhat affronted by Britain’s largest builder, Balfour Beatty, who last week gave water and gas firms the boot. And what’s more, it seems to be part of trend. Skanska announced it was marching away at its results last month. There’s speculation another large firm could follow.

But once the indignity subsides, should those in charge of the capital spend be worried by the departure of these firms? Or is it “so what”?

Certainly, the mood music coming from utilities – and water firms especially- is that they are taking Tier 1 suppliers off their tender list in favour of contracting directly with Tier 2s. Or as one delegate put it at a round table debate some 12 months ago, Tier 1.5 – medium-sized companies that are not the big household names of the contracting world.

Instead, he and others taking part in this Utility Week event explained that rather than hand out work to the big corporate builders they were looking to become so-called intelligent clients in order to cut what is increasingly being seen as an unnecessary layer of costs. Tier 1 contractors tend to orchestrate the project, subcontracting out the construction work to smaller firms.

The time is right for this shift because it chimes with a move away from the construction of huge and complex new schemes, to a higher volume of lower-value maintenance projects, as our delegates made clear. Clients also voiced frustration at being given the ‘C’ team to run their jobs – with the best people creamed off to build HS2 and the like.  And as the frameworks for water companies have come through in AMP7, some of the bigger names have been noticeable by their absence. So, in one sense Balfour looked like having the choice made for it.

Even so, when announcing the exit plan, Leo Quinn, Balfour’s CEO, was on the front foot and pointed to wafer thin margins, high risks and heavy working capital demands in the sector and made it clear they were the active party in making the split.

“Under the new AMP7 regulatory period (2020-2025) contracts are generally being awarded on terms that are not acceptable to Balfour Beatty, “he said, “and therefore the group is only expected to retain the Anglian Water contract.”

The contractor had already signalled its intention to pull out of gas work some months earlier, which it also reaffirmed in its results. “The group continues to manage two long-term gas contracts in the RIIO-GD1 period – until early 2021 – which have historically underperformed and have also been negatively impacted by Covid-19.

“The gas market is no longer considered viable to the group because of the unfavourable working capital and onerous terms and conditions.” Again, portraying a tougher, more principled party refusing to be a victim and standing up for itself.

Learning the hard way

There will be admiration for Balfour Beatty turning its back on unsustainable contracts, for having learnt its lessons the hard way. In fact, admiration from anyone who has watched the grim spectacle unfold since 2014 with builder after builder reporting losses that add up to the national debt of a small country,

During the last recession all the major contractors got caught out “buying” work to keep turnover as projects work dried up, only to see the chickens come home to roost later when costs started rising.  By mid-2014 for example, Balfour Beatty seemed to be issuing a profit warning every week. It got so bad that they were the subject of takeover challenges from the smaller Carillion – whose own parlous state emerged just a few years later. Even as late as 2019, Construction News was reporting that the average pre-tax margin of the 10 largest contractors in the UK by turnover was still minus 0.1 per cent. The fact that this represented an increase for the first time in five years says it all.  “Across the group, the average margin increased to -0.1 per cent, up from -0.9 percent,” it reported.  Balfour Beatty has been one of the better performers, but again went into the red in its recent results.

Quinn’s move won’t surprise other contractors in the utility sector who have been sounding the alarm bells for some time. Firms of all sizes are concerned that water (and its assumed in the coming months/years, energy firms), are passing the tough determinations from the regulators onto their suppliers. The notion of innovation and sustainability has been sacrificed on the altar of cutting costs, rather than adding the value they claim. Regulators and companies no doubt feel that it’s all part of the great poker game: and that contractors are never been happy with any hand they are dealt.

Clients will point out that even though the bigger ones are walking, that doesn’t mean that smaller firms with lower overheads can’t make the numbers stack up. This view undoubtedly has merit.  And given also the downturn in other market sectors, we shouldn’t expect a shortage of firms queuing up to fill Balfour Beatty’s shoes – no doubt staffed up by those who used to work for bigger firms, no longer in the sector.

Unintended consequences

However, utility firms would be rash to dismiss Balfour’s departure as “so what?” It really does confirm that despite all they have going in their favour – safe solid companies who always pay on time – onerous contract conditions have finally tipped the balance of cons outweighing the pros for some sector stalwarts. Balfour and Skanska’s stance may well spark other contractors to rethink what they are doing staying put in the sector.

There’s no immediate need to worry about a shortage on the tender list, but water and energy firms need to look hard and think twice about the deals they strike. Are big firms quitting because conditions really are financially suicidal? Or is it because they can’t make the contracts work within their own corporate structures.? Are clients playing fair?

The success or failure of AMP7 delivery and energy spending coming down the line relies on making the right judgement call. Pushing contractors too far so they end up taking on work at negative margins doesn’t do anyone favours.

As construction sees its sharpest decline on record, the Tier 2s or Tier 1.5s might be less likely to turn their back on the sector. But if they too are driven out of utilities in a couple of years’ time, bust or bruised, leaving chaos in their wake, then the contracts being struck now may not look quite the bargain energy and water chiefs thought they were getting.